What you need to know before investing in cryptocurrency

17 August 2021 | Posted by Frankie Jones
Woman holding bitcoin

Cryptocurrency is becoming more popular by the day, with everyone from Elon Musk to Ashton Kutcher jumping on the bandwagon. While it might seem like an easy way to make a quick buck for 2.3 million Brits who currently own crypto, there are risks involved. We’ve rounded up the key facts you need to know before you take the plunge into cryptocurrency.

What is cryptocurrency?

Cryptocurrency (or ‘crypto’) is a virtual currency that uses cryptography as a means of security.

Crypto operates on an open network. This means you buy the digital currencies peer-to-peer rather than from a bank or other central authority. The benefits of decentralised currency are that you don’t have to pay central processing fees and mining fees are generally lower. It’s also a cross-border currency as opposed to a border-locked currency.

Unlike physical payment methods, like cash, crypto is stored and traded electronically. But because it’s not based on an actual asset, it doesn’t have any traditional tangible value. Instead, supply and demand determine its value. So it’s only worth as much as a buyer is willing to pay (this is known as ‘speculation’).

What are the main types of cryptocurrency?

Bitcoin – Probably the most popular form of crypto, bitcoin is considered ‘cash for the internet’.

Ethereum – A bit like an app store, the ‘ether’ currency is used by app developers and users.

Bitcoin cash – This has a bigger block size (8MB) compared to bitcoin (1MB) which means it offers faster processing speeds.

Dogecoin – What started as a satirical homage to bitcoin, Dogecoin is now one of the top four cryptocurrencies by market value.

Ripple – Unlike many others on this list, Ripple isn’t a blockchain-based currency. It’s designed for big companies to move money around the world.

Stellar – Stellar’s goal is to help developing economies that may not have access to traditional banks and investment opportunities by making money transfers faster and more efficient.

Litecoin – Similar to bitcoin, this currency offers shorter transaction times, lower fees and more concentrated miners.

NEO – Developed in China, NEO focuses on digital contracts that allow users to create and execute agreements without the use of an intermediary.

Cardano – Cardano is used to send and receive digital funds, claiming to be a more balanced and sustainable ecosystem for cryptocurrencies.

IOTA  – IOTA, which stands for Internet of Things Application, works with smart devices on the Internet of Things (IoT).

Make sure you understand the risks before investing

What are the practical uses?

There are a number of risks associated with crypto, one of which is the doubts that have been cast about their practical use. That being said, more and more companies (Expedia, for instance) are beginning to accept crypto as a form of payment.

Crypto isn’t regulated

That means if you buy any kind of crypto asset, you probably won’t have access to the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS) if something goes wrong. The FCA has previously referred to crypto as “very high risk, speculative purchases.”

For example, the FCA recently shut down Binance, a platform that described itself as “the world’s largest crypto exchange”.

It’s unpredictable

It’s also notoriously unpredictable (or ‘volatile’ in the investing world). Because the price fluctuates based on supply and demand, it’s very difficult to know when to buy and sell. Bitcoin’s value fell by a massive 30% in May, for example. You should be aware that there’s a high risk of losses when you invest in crypto.

There are fees involved

Don’t forget about the impact fees can have on investments. As with most investing platforms, you’ll probably be charged a fee (whether that’s a one-off or ongoing charge). So it’s worth checking how much this would eat into your potential returns. 

Watch out for scams

Lastly, be wary of scams and firms overestimating the returns you could receive. Scams can include a currency that doesn’t exist or a fake investment into a legitimate cryptocurrency. It could even be a dangerous website that could download a virus onto your device. Be cautious if a company contacts you out of the blue, puts pressure on you to make a quick decision or if it seems too good to be true.

While not exactly a scam, many companies (especially those that aren’t regulated) can lie about the returns you could see on crypto. They do this in the hope that you’ll invest more money. So make sure you check this thoroughly before investing. 

How to buy cryptocurrency

The most common place to buy crypto is through specialist exchanges, such as Coinbase.

Usually, you have to provide your passport details, phone number and email address to create an account. The costs of trading can vary from one exchange to another, so it’s best to shop around and find the best deal. While some providers impose a single fee per trade, others will ask you for a percentage of the overall transaction.

Remember to declare any earnings at the end of the year, as this will be submitted to HMRC.

Should you invest in cryptocurrency?

Ultimately, when you invest in crypto (or anything, actually) the most important thing to do is understand your appetite for risk and your capacity for risk. 

Your appetite refers to how adventurous or cautious you want to be. Maybe you’re willing to take a bit more risk in order to make potentially higher returns? Or maybe you’d rather play it safe, knowing you might not make such significant returns. Given crypto is a high risk investment, ideally you should think of it as a long-term investment in order to ride out any price volatility. So if you’re prepared to leave your crypto investments for 10 years+, then it could work for you.

Your capacity refers to whether you can take risks. For example, do you have an emergency fund of 3 months’ worth of expenses saved up? Have you made sure to diversify your investments (i.e. not putting all your money into crypto)? Generally you should only invest a small percentage of your overall investment plan in crypto. Are you being careful to only invest as much as you can afford? If so, then you likely have the capacity to take some risk. 

Not sure what to invest in?

If you’re weighing up your options when it comes to investing, remember, you can invest in pretty much anything these days. From gold to property, shares and bonds. Download the Claro app, create your account and start your investing journey now.

When investing, your capital is at risk. Please note that this is not financial advice.

Tax treatment depends on your individual circumstances and is subject to change in the future.

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